QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

OR

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

COMMISSION FILE NO. 000-26937

QUEST SOFTWARE, INC.

(Exact name of registrant as specified in its charter)

Delaware

33-0231678

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

5 Polaris Way

Aliso Viejo, California

92656

(Address of principal executive offices)

(Zip code)

Registrants telephone number, including area code: (949) 754-8000

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No
¨

Indicate by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).

Yes x No
¨

Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange
Act.

Large accelerated filer

x

Accelerated filer

¨

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

The number of shares outstanding of the registrants Common Stock as of October 28, 2010, was 88,432,196.

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

QUEST SOFTWARE, INC.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED INCOME STATEMENTS

(In thousands, except per share data)

(Unaudited)

Three Months EndedSeptember 30

Nine Months EndedSeptember 30

2010

2009

2010

2009

Revenues:

Licenses

$

80,582

$

67,323

$

222,663

$

191,333

Services

112,460

103,526

327,652

309,371

Total revenues

193,042

170,849

550,315

500,704

Cost of revenues:

Licenses

2,465

2,197

6,178

5,740

Services

16,907

14,607

47,267

42,867

Amortization of purchased technology

4,105

4,983

12,564

14,924

Total cost of revenues

23,477

21,787

66,009

63,531

Gross profit

169,565

149,062

484,306

437,173

Operating expenses:

Sales and marketing

74,107

64,704

214,529

196,732

Research and development

38,124

34,721

110,140

107,928

General and administrative

21,585

18,971

60,758

55,170

Litigation loss provision



29,400



29,400

Amortization of other purchased intangible assets

3,186

3,258

9,512

9,925

Total operating expenses

137,002

151,054

394,939

399,155

Income (loss) from operations

32,563

(1,992

)

89,367

38,018

Other income (expense), net

1,743

2,703

(5,706

)

3,338

Income before income tax provision (benefit)

34,306

711

83,661

41,356

Income tax provision (benefit)

5,805

(2,238

)

22,158

8,019

Net income

$

28,501

$

2,949

$

61,503

$

33,337

Net income per share:

Basic

$

0.31

$

0.03

$

0.68

$

0.36

Diluted

$

0.31

$

0.03

$

0.66

$

0.35

Weighted-average shares:

Basic

90,540

88,968

89,883

92,540

Diluted

93,161

91,846

92,522

94,483

The accompanying notes
are an integral part of these condensed consolidated financial statements.

4

QUEST SOFTWARE, INC.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

Nine Months
EndedSeptember 30

2010

2009

Cash flows from operating activities:

Net income

$

61,503

$

33,337

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization

32,493

36,596

Compensation expense associated with share-based payments

15,526

11,366

Deferred income taxes

5,237

1,184

Excess tax benefit related to stock-based compensation

(2,211

)

(639

)

Provision for bad debts

641

120

Litigation loss provision



29,400

Other non-cash adjustments, net

370

(544

)

Changes in operating assets and liabilities, net of effects of acquisitions:

Accounts receivable

14,248

32,128

Prepaid expenses and other current assets

3,357

(34

)

Other assets

1,704

1,687

Accounts payable

1,371

(1,988

)

Accrued compensation

(4,294

)

(7,691

)

Other accrued expenses

(1,817

)

(10,584

)

Income taxes payable

(7,165

)

(8,280

)

Deferred revenue

3,161

(3,733

)

Other liabilities

(1,513

)

3,508

Net cash provided by operating activities

122,611

115,833

Cash flows from investing activities:

Cash paid for acquisitions, net of cash acquired

(55,029

)



Purchases of property and equipment

(11,265

)

(8,277

)

Cash paid for software rights

(2,229

)



Change in restricted cash

767

1,690

Purchases of cost method investments



(3,000

)

Purchases of investment securities

(216,193

)

(11,993

)

Sales and maturities of investment securities

139,322

1,289

Notes receivable from a cost method investee

(2,000

)



Acquisition related payments

(2,029

)

(96

)

Net cash used in investing activities

(148,656

)

(20,387

)

Cash flows from financing activities:

Proceeds from loans payable



68,428

Repayment of loans payable

(32,466

)

(782

)

Repurchase of common stock

(37,373

)

(101,119

)

Repayment of capital lease obligations

(190

)

(193

)

Cash paid for line of credit fees



(1,979

)

Proceeds from the exercise of stock options

37,271

27,600

Excess tax benefit related to share-based compensation

2,211

639

Net cash used in financing activities

(30,547

)

(7,406

)

Effect of exchange rate changes on cash and cash equivalents

918

(470

)

Net (decrease) increase in cash and cash equivalents

(55,674

)

87,570

Cash and cash equivalents, beginning of period

292,940

215,895

Cash and cash equivalents, end of period

$

237,266

$

303,465

Supplemental disclosures of consolidated cash flow information:

Cash paid for interest

$

2,557

$

2,858

Cash paid for income taxes

$

23,540

$

13,514

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

QUEST SOFTWARE, INC.
AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

Three Months
EndedSeptember 30

Nine Months
EndedSeptember 30

2010

2009

2010

2009

Net income

$

28,501

$

2,949

$

61,503

$

33,337

Other comprehensive (loss) income:

Unrealized loss on foreign currency hedges, net of tax

(1,819

)

(2

)

(1,768

)

(2

)

Unrealized income on available-for-sale securities, net of tax

409



398



Comprehensive income

$

27,091

$

2,947

$

60,133

$

33,335

The accompanying notes are an integral part of these condensed consolidated financial statements.

6

QUEST SOFTWARE, INC.
AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

NOTE 1  ORGANIZATION AND BASIS OF PRESENTATION

Quest Software, Inc. was incorporated in California in 1987 and reincorporated in Delaware in 2009. We are a leading developer and vendor of application, database, Windows and virtualization management
software products. We also provide consulting, training, and support services to our customers. References to Quest, Quest Software, the Company, we, us, or our refer to Quest
Software, Inc. and its consolidated subsidiaries.

Our accompanying unaudited condensed consolidated financial statements as
of September 30, 2010 and for the three and nine months ended September 30, 2010 and 2009 reflect all adjustments (consisting of normal recurring accruals) that, in the opinion of management, are necessary for a fair presentation of the
results for the interim periods presented. These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. Certain immaterial amounts were not shown separately
and immaterial reclassifications have been made to prior year amounts to conform to the current year presentation.

The
information included in this Quarterly Report on Form 10-Q should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations, Quantitative and Qualitative Disclosures
About Market Risk, and the Consolidated Financial Statements and Notes to the Consolidated Financial Statements included in Quests Annual Report on Form 10-K for the year ended December 31, 2009 (2009 Form
10-K). The results for the interim periods presented are not necessarily indicative of the results that may be expected for any future period.

NOTE 2  RECENT ACCOUNTING PRONOUNCEMENTS

In October 2009, Financial
Accounting Standards Board (FASB) issued an amendment to its accounting guidance on revenue arrangements with multiple deliverables. This new accounting guidance addresses the unit of accounting for arrangements involving multiple
deliverables and how consideration should be allocated to separate units of accounting, when applicable. This guidance will be effective for fiscal years beginning on or after June 15, 2010. This guidance will not have a material impact on our
consolidated financial position or results of operations.

In October 2009, FASB issued an amendment to its accounting
guidance on certain revenue arrangements that include software elements. The new accounting guidance excludes from consideration of software revenue recognition principles all tangible products containing both software and non-software components
that function together to deliver the products essential functionality. This guidance will be effective for fiscal years beginning on or after June 15, 2010. This guidance must be adopted in the same period that the company adopts the
amended accounting for arrangements with multiple deliverables described in the preceding paragraph. This guidance will not have a material impact on our consolidated financial position or results of operations.

In December 2009, FASB issued new guidance regarding improvements to financial reporting by enterprises involved with variable interest
entities. The new guidance provides an amendment to its consolidation guidance for variable interest entities and the definition of a variable interest entity and requires enhanced disclosures to provide more information about an enterprises
involvement in a variable interest entity. This amendment also requires ongoing assessments of whether an enterprise is the primary beneficiary of a variable interest entity and is effective January 1, 2010. There was no impact from adoption of
this guidance on our consolidated financial position or results of operations.

In January 2010, FASB issued an amendment to
its accounting for distributions to shareholders with components of stock and cash. This new guidance clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or shares with a potential limitation
on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance. This guidance is effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a
retrospective basis. There was no impact from adoption of this guidance since we have never declared dividends on our common stock.

In January 2010, FASB issued an amendment to its accounting and reporting for decreases in ownership of a subsidiary. This amendment clarifies the scope of the decrease in ownership provisions in the
consolidation  overall subtopic and related guidance. This amendment is effective beginning in the period that an entity adopts FASBs guidance on Noncontrolling Interests in Consolidated Financial Statements, which was effective
January 1, 2009 for us. There was no impact from the adoption of this guidance on our consolidated financial position or results of operations.

In January 2010,
FASB issued an amendment regarding improving disclosures about fair value measurements. This new guidance requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement. The new disclosures and
clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in
Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. There was no impact from the adoption of this guidance to our consolidated
financial position or results of operations as the amendment only addresses disclosures.

In February 2010, FASB issued an
amendment to certain recognition and disclosure requirements relating to subsequent events. This amendment removes the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised
financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of U.S. Generally Accepted Accounting Principles (GAAP). The amendment is
effective upon issuance of the final update. There was no impact from the adoption of this guidance on our consolidated financial position or results of operations as the amendment only addresses disclosures.

In March 2010, FASB issued an amendment to Derivatives and Hedging-Embedded Derivatives. The amendment provided clarifications and
related additional examples to improve financial reporting by resolving potential ambiguity about the breadth of the embedded credit derivative scope exception. The amendment is effective for each reporting entity at the beginning of its first
fiscal quarter beginning after June 15, 2010. We do not expect adoption of this guidance to have an impact on our consolidated financial position or results of operations as we do not have contracts containing embedded credit derivative
features.

In April 2010, FASB issued an amendment to Stock Compensation. The amendment clarifies that an employee
stock-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entitys equity shares trades should not be considered to contain a condition that is not a market, performance, or
service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning on or after
December 15, 2010. We do not expect adoption of this guidance to have an impact to us since our stock-based payment awards have an exercise price denominated in the same currency of the market in which our Company shares are traded.

In July 2010, FASB issued an amendment to Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit
Losses. The amendment enhances disclosures about the credit quality of financing receivables and the allowance for credit losses. This Update requires an entity to provide a greater level of disaggregated information about the credit quality of
its financing receivables and its allowance for credit losses. In addition, the amendments in this Update require an entity to disclose credit quality indicators, past due information, and modifications of its financing receivables. These
improvements will help financial statement users assess an entitys credit risk exposures and its allowance for credit losses. The amendment is effective for interim and annual periods ending on or after December 15, 2010. We do not expect
adoption of this guidance to have an impact to us since we do not have any financing receivables.

NOTE 3  ACQUISITIONS

Völcker Informatik AG  In July 2010, we acquired 100% voting equity interest of
Germany-based Völcker Informatik AG (Völcker), a privately held identity management solutions provider, for cash consideration of approximately $20.2 million. The acquisition further extends the Quest® One Identity Solution product portfolio. In connection with the acquisition, Quest also agreed to certain
post-closing payments with a maximum potential payout of approximately $5.0 million paid over three years, of which $2.5 million relates to an earn-out contingent upon achieving certain sales targets and the remainder to retention bonuses tied to
continued employment. The estimated fair value of the earn-out contingency of $2.0 million has been recorded as an accrual, making the total purchase price approximately $22.2 million.

The earn-out contingency requires payments of up to $2.5 million that will be due and payable if certain levels of billings to customers
for Völcker products are met during the three-year period subsequent to the close of the acquisition. The fair value

of the earn-out contingency was determined using the income approach with significant inputs that are not observable in the market. A key assumption is a discount rate consistent with our
estimated pre-tax cost of debt. The expected outcomes were recorded at net present value. Subsequent changes in the fair value of the earn-out contingency will be recorded in earnings.

The acquisition has been accounted for as a business combination and the purchase price was allocated primarily to goodwill and other
intangible assets. Actual results of operations of Völcker are included in our consolidated financial statements from the date of acquisition. Our preliminary allocation of the purchase price to assets and liabilities based upon fair value
determinations was as follows (in thousands):

Current assets

$

2,823

Acquired technologies with a useful life of 4.5 years

5,416

Customer relationships with a useful life of 4.5 years

3,401

Goodwill

13,930

Other assets

490

Current liabilities

(1,246

)

Deferred income tax liabilities  non-current

(2,645

)

Total purchase price

$

22,169

The preliminary allocation of purchase price for Völcker was based upon valuation information and
estimates and assumptions available at the time of filing. Our estimates and assumptions are subject to change and preliminary valuations are often finalized after a reporting period. The areas of the purchase price allocation that are not yet
finalized and are subject to change within the measurement period relate to the valuation of certain intangible assets, deferred revenue, income taxes and resulting goodwill.

The intangible assets will be amortized over the pattern in which the economic benefits of the intangible assets are being utilized, which in general reflects the cash flows generated from such assets.
The goodwill associated with this acquisition is reported within our license and service segments of our business, and is not expected to be deductible for tax purposes. The goodwill allocation of 50% to licenses and 50% to services is based on both
historical and projected relative contribution from licenses and services revenues. Goodwill results from expected synergies from the transaction, including complementary products that will enhance our overall product portfolio, and opportunities
within new markets, which we believe will result in incremental revenue and profitability.

The pro forma effects of
Völcker would not have been material to our results of operations for the nine months ended September 30, 2010 and 2009, and therefore are not presented.

The
acquisition has been accounted for as a business combination and the purchase price was allocated primarily to goodwill and other intangible assets. Actual results of operations of Surgient are included in our consolidated financial statements from
the date of acquisition. Our preliminary allocation of the purchase price to assets and liabilities based upon fair value determinations was as follows (in thousands):

The preliminary allocation of purchase price for Surgient was based upon valuation
information and estimates and assumptions available at the time of filing. Our estimates and assumptions are subject to change and preliminary valuations are often finalized after a reporting period. The areas of the purchase price allocation
that are not yet finalized and are subject to change within the measurement period relate to the valuation of certain intangible assets, deferred revenue, income taxes and resulting goodwill.

The intangible assets will be amortized over the pattern in which the economic benefits of the intangible assets are being utilized,
which in general reflects the cash flows generated from such assets. We acquired one in-process research and development (IPR&D) project. The value assigned to the IPR&D project was determined utilizing the income approach by
determining cash flow projections relating to the project. We applied a discount rate of 12% to determine the value of the IPR&D project. The IPR&D project will be assessed for impairment until completed. Upon completion, the project will be
amortized over its estimated useful life over the pattern in which the economic benefit of the intangible asset is being utilized. The goodwill associated with this acquisition is reported within our license and service segments of our business, and
is not expected to be deductible for tax purposes. The goodwill allocation of 55% to licenses and 45% to services is based on both historical and projected relative contribution from licenses and services revenues. Goodwill results from expected
synergies from the transaction, including complementary products that will enhance our overall product portfolio, and opportunities within new markets, which we believe will result in incremental revenue and profitability.

The pro forma effects of Surgient would not have been material to our results of operations for the nine months ended September 30,
2010 and 2009, and therefore are not presented.

NOTE 4  GEOGRAPHIC AND SEGMENT REPORTING

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated
regularly by our chief operating decision maker, or decision-making group, in assessing performance and deciding how to allocate resources.

Our reportable operating segments are Licenses and Services. The Licenses segment develops and markets licenses to use our software products. The Services segment provides after-sale support for software
products and fee-based training and consulting services related to our software products.

We do not separately allocate
operating expenses to these segments, nor do we allocate specific assets to these segments. Therefore, segment information reported includes only revenues, cost of revenues, and gross profit.

Reportable segment data for the three and nine months ended September 30, 2010 and 2009 is as follows (in thousands):

Revenues are
attributed to geographic areas based on the location of the Quest entity from which the products or services were invoiced. Revenues and long-lived assets concerning principal geographic areas in which we operate are as follows (in thousands):

United States

Ireland

OtherInternational (2)

Total

Three months ended/As of September 30, 2010:

Revenues

$

126,506

$

22,892

$

43,644

$

193,042

Long-lived assets (1)

86,011

6

12,998

99,015

Three months ended/As of September 30, 2009:

Revenues

$

108,656

$

15,951

$

46,242

$

170,849

Long-lived assets (1)

84,625

15

13,222

97,862

Nine months ended/As of September 30, 2010:

Revenues

$

346,797

$

66,439

$

137,079

$

550,315

Long-lived assets (1)

86,011

6

12,998

99,015

Nine months ended/As of September 30, 2009:

Revenues

$

314,543

$

45,645

$

140,516

$

500,704

Long-lived assets (1)

84,625

15

13,222

97,862

(1)

Includes property and equipment, net and other assets

(2)

No single location within Other International accounts for greater than 10% of total revenues

NOTE 5  CASH AND CASH EQUIVALENTS AND INVESTMENTS

The following
table summarizes our cash and cash equivalents and investments by balance sheet classification at the dates indicated (in thousands):

At December 31, 2009, we held $47.6 million par value (with a fair value of $44.2
million) in municipal notes with an auction reset feature (auction rate securities or ARS). In October 2008, we entered into agreements (the Agreements) with the investment firm that sold us our ARS. By
entering into the Agreements, we (1) received the right (Put Options) to sell all of our ARS back to the investment firm at par, at our sole discretion, anytime during the period from June 30, 2010 through July 2, 2012,
(2) gave the investment firm the right to purchase all of our ARS or sell them on our behalf at par anytime after the execution of the Agreements through July 2, 2012, (3) received an offer for a no net cost loan for up to
70% of the par value of the ARS until June 30, 2010, and (4) agreed to release the investment firm from certain potential claims related to the collateralized ARS in certain specified circumstances. We exercised our Put Options on
July 1, 2010 under the Agreements with the investment firm that sold us our ARS and the investment firm transferred our remaining ARS of $4.5 million par value out of our account and replaced with cash, fulfilling their obligation under the
Agreements and reducing our auction rate securities to zero.

NOTE 6  GOODWILL AND INTANGIBLE ASSETS, NET

The changes in the carrying amount of goodwill by reportable operating segment for the nine months ended September 30, 2010 are as
follows (in thousands):

Licenses

Services

Total

Balance as of December 31, 2009

$

470,934

$

199,547

670,481

Acquisitions (1)

17,837

15,860

33,697

Adjustments (2)

809

387

1,196

Balance as of September 30, 2010

$

489,580

$

215,794

$

705,374

(1)

Refer to Note 3  Acquisitions for additional details.

(2)

Primarily from post-acquisition payment obligations to former shareholders of acquisitions we made in 2007 pursuant to accounting principles applicable to acquisitions
in that year offset by $0.9 million primarily from income tax related purchase price allocation adjustments for our December 2009 acquisition of PacketTrap, Inc.

Intangible assets, net are comprised of the following (in thousands):

September 30, 2010

December 31, 2009

GrossCarryingAmount

AccumulatedAmortization

Net

GrossCarryingAmount

AccumulatedAmortization

Net

Acquired technology and IPR&D (1)

$

163,143

$

(130,032

)

$

33,111

$

154,247

$

(117,424

)

$

36,823

Customer relationships

74,318

(47,686

)

26,632

69,577

(39,438

)

30,139

Non-compete agreements

13,919

(13,007

)

912

13,919

(12,176

)

1,743

Trademarks and trade names (2)

13,302

(6,133

)

7,169

13,080

(5,713

)

7,367

$

264,682

$

(196,858

)

$

67,824

$

250,823

$

(174,751

)

$

76,072

(1)

With our 2009 acquisition of PacketTrap and this quarters acquisition of Surgient, IPR&D projects were identified and valued. These projects will be assessed
for impairment. Upon completion, the projects will be amortized over its estimated useful life.

(2)

Trademarks and trade names include $6.2 million and $0.8 million in trade names related to our acquisition of ScriptLogic and PacketTrap, respectively, that each have
an indefinite useful life, and as such are not being amortized.

Amortization expense for amortizing intangible
assets was $7.3 million and $22.1 million for the three and nine months ended September 30, 2010, respectively. This compares to $8.2 million and $24.8 million for the three and nine months ended September 30, 2009, respectively.

Our investments in early stage private companies do not have a readily determined market value and are accounted for under the cost method, given that we do not have the ability to exercise significant
influence. Our cumulative investments in four non-consolidated companies and one private equity fund are included as part of Other assets in our condensed consolidated balance sheets and carried at $16.5 million and $14.4 million as of
September 30, 2010 and December 31, 2009, respectively. In the first quarter of 2010, we had $2.0 million in notes receivable from a cost method investee included in Other assets in our condensed consolidated balance sheet. The loan bore
interest on the outstanding principal amount at the rate of 10% per annum. The note was due and payable on November 1, 2011. In August 2010, the principal amount plus all accrued interest under the notes receivable was converted into
equity and was reclassified to cost method investments.

NOTE 8  LOANS PAYABLE

In February 2009, we entered into a two year revolving line of credit agreement with Wells Fargo Foothill, LLC as the arranger,
administrative agent and lender. We intend to use any proceeds from the credit agreement for working capital and other general corporate purposes. The credit agreement allows for cash borrowings and letters of credit under a secured revolving credit
facility of up to a maximum of $100 million. Interest will accrue at a floating rate based on, at the Companys election, (i) LIBOR (subject to reserve requirements and a minimum LIBOR of 2.75%) or (ii) the greatest of (a) 4.0%,
(b) the Federal Funds Rate plus 0.5% or (c) Wells Fargos prime rate, in each case, plus an applicable margin. The credit agreement includes limitations on the Companys ability to, among other things, incur debt, grant liens,
make acquisitions and other investments, make certain restricted payments such as dividend payments, and dispose of assets. The credit agreement is secured by substantially all of the Companys assets, subject to certain exceptions including
the Company headquarters facility, and includes certain financial covenants. Total fees associated with this line of credit were approximately $2.0 million and will be amortized over the life of the credit agreement as interest expense. For the
three and nine months ended September 30, 2010, $0.2 million and $0.7 million, respectively, in amortization of these fees was recognized as interest expense within other income (expense), net. As of September 30, 2010, we have a zero
balance outstanding under this line of credit.

In August 2009, we entered into a loan agreement with Mutual of Omaha Bank
whereby we borrowed an aggregate principal amount of $34 million. The loan is secured by our real property at our headquarters in Aliso Viejo, California. We intend to use the proceeds from the loan for working capital and other general corporate
purposes. The loan matures in five years, during which time we will make equal monthly principal and interest payments at a 7.03% interest rate on a fixed rate, 25-year amortization schedule. Events of default include, among other things, payment
defaults, breaches of covenants and bankruptcy events. In the case of a continuing event of default, the lender may, among other things, accelerate the payment of any unpaid principal and interest amounts, increase the then-current interest rate by
5% and foreclose on the real estate collateral. As of September 30, 2010, we have a $33.4 million balance outstanding with $0.5 million recorded as current and $32.9 million recorded as long-term portion of loans payable.

We were in compliance with all debt-related covenants at September 30, 2010.

Our foreign currency gains (losses), net are predominantly attributable to translation gains or losses on the re-measurement of our net balances of monetary assets and
liabilities in our foreign subsidiaries, including accounts receivable and cash, which were primarily denominated in the Euro, and to a lesser extent, the British Pound and Canadian Dollar. The foreign currency translation adjustments to these
balance sheet items are calculated by comparing the currency spot rates at the end of a month to the spot rates at the end of the previous month.

(2)

Relates to changes in fair value of our foreign currency contracts not designated as hedging instruments. See Note 14  Derivative Instruments for further details.

NOTE 10  INCOME TAX PROVISION

During the three and nine months ended September 30, 2010, the income tax provision (benefit) increased to $5.8 million and $22.2 million, respectively from $(2.2) million and $8.0 million in the
comparable period in 2009. The effective income tax rate for the three and nine months ended September 30, 2010 was approximately 16.9% and 26.5%, respectively from (314.8)% and 19.4% in the comparable period of 2009. The increase is
primarily a result of the mix of pre-tax income between high and low tax jurisdictions and settlement of the shareholder class action in the third quarter of 2009 related to our completed stock option investigation impacting the three and nine
months ended September 30, 2010.

NOTE 11  NET INCOME PER SHARE

Basic net income per share is computed by dividing net income available to common stockholders by the weighted-average number of common
shares outstanding for the period. Diluted net income per share reflects the potential dilution of securities by including other common stock equivalents, including stock options and restricted stock units, in the weighted-average number of common
shares outstanding for a period, if dilutive.

The table below sets forth the reconciliation of the denominator of the net
income per share calculation (in thousands):

Three Months
EndedSeptember 30

Nine Months
EndedSeptember 30

2010

2009

2010

2009

Shares used in computing basic net income per share

90,540

88,968

89,883

92,540

Dilutive effect of stock options and restricted stock units (1)

2,621

2,878

2,639

1,943

Shares used in computing diluted net income per share

93,161

91,846

92,522

94,483

(1)

Options to purchase 7.2 million and 3.7 million shares of common stock were outstanding during the three months ended September 30, 2010 and 2009,
respectively, and 6.0 million and 8.9 million shares of common stock during the nine months ended September 30, 2010 and 2009, respectively, were outstanding but were not included in the computation of diluted net income per share as
inclusion would have been anti-dilutive.

On August 9, 2009, the Board of Directors authorized a plan to repurchase up to $100 million of Quests common stock. Any
stock repurchases may be made through open market and privately negotiated transactions, at times and in such amounts as management deems appropriate, including pursuant to one or more Rule 10b5-1 trading plans. Rule 10b5-1 permits Quest to
establish, while not in possession of material nonpublic information, prearranged plans to buy stock at a specific price in the future, regardless of any subsequent possession of material nonpublic information. The timing and actual number of
shares repurchased will depend on a variety of factors including market conditions, corporate and regulatory requirements, and capital availability. The stock repurchase program does not have an expiration date and may be limited or terminated at
any time without prior notice. During the quarter ended September 30, 2010, we have no stock repurchases under this plan. A total of $51.5 million remains available pursuant to this stock repurchase authorization.

NOTE 13  STOCK-BASED COMPENSATION

We offer stock-based awards to employees, directors and consultants under the Quest Software, Inc. 2008 Stock Incentive Plan (the 2008 Plan). The 2008 Plan was adopted by our Board of
Directors as a means to secure and retain the services of our employees, directors, and consultants, to provide such eligible individuals an opportunity to benefit from increases in the value of our Common Stock through the grant of stock awards,
and thereby align the long-term compensation and interests of those individuals with our stockholders.

The 2008 Plan provides
for the discretionary grant of incentive stock options, non-statutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights, and other forms of equity compensation (collectively, the stock
awards). The number of shares of Common Stock available for issuance under the 2008 Plan is 24.5 million as of September 30, 2010. The number of shares of Common Stock reserved for issuance under the 2008 Plan will be reduced by 1
share for each share of Common Stock issued under the 2008 Plan pursuant to a stock option and by 1.94 shares for each share of Common Stock issued under the 2008 Plan pursuant to a restricted stock award, restricted stock unit award, or other stock
award. As of September 30, 2010, there were 8.7 million shares available for grant under the 2008 Plan.

Stock
Option Awards

The fair value of each option award is estimated on the date of grant using a Black-Scholes option
valuation model that uses the assumptions noted in the following table. The fair value of these awards is amortized on a straight-line basis over the vesting period. Expected volatilities are based on historical volatilities of Quests stock.
We use historical data to estimate option exercise and employee termination within the valuation model; separate groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The risk-free rate
is based on the U.S. Treasury zero-coupon issues in effect at the time of option grant for equivalent remaining terms. We do not expect to pay any dividends and, therefore, we use an expected dividend yield of zero.

We used the following weighted-average assumptions for option awards granted during the three months and nine months ended
September 30, 2010 and 2009:

A summary of the activity of employee stock options during the nine months ended
September 30, 2010, and details regarding the options outstanding and exercisable at September 30, 2010, are provided below:

Number ofShares(in thousands)

Weighted-AverageExercise
Price(per share)

Weighted-AverageRemainingContractual Term(in years)

AggregateIntrinsic
Value(in thousands) (2)

Outstanding at December 31, 2009

13,400

$

16.77

Granted (1)

5,720

$

18.90

Exercised

(2,881

)

$

12.94

Canceled/forfeited/expired

(1,319

)

$

34.48

Outstanding at September 30, 2010

14,920

$

16.76

6.36

$

118,633

Vested or expected to vest at September 30, 2010

13,971

$

16.66

6.15

$

112,594

Exercisable at September 30, 2010

6,983

$

15.23

2.96

$

67,156

(1)

Most of this was stock options granted in the third quarter of 2010 that are performance-based under our Managing For Results Profit Sharing Plan, and are
subject to change.

(2)

These amounts represent the difference between the exercise price and $24.59, the closing price of Quest Software, Inc. stock on September 30, 2010 as reported on
the NASDAQ National Market, for all options outstanding that have an exercise price currently below the closing price.

The weighted-average fair value of options granted during the nine months ended September 30, 2010 and 2009 was $7.08 and $5.39, respectively. The total intrinsic value of options exercised was $18.9
million and $8.2 million for the nine months ended September 30, 2010 and 2009, respectively. The total fair value of options vested during the nine months ended September 30, 2010 and 2009 was $4.9 million and $6.9 million, respectively.

Restricted Stock Unit Awards (RSU Awards)

RSU awards have been granted to selected executives pursuant to our Executive Incentive Plan. We have also granted RSU awards to key
employees pursuant to the Managing For Results Profit Sharing Plan. All of our outstanding RSU awards vest over three years with vesting contingent upon continuous service and meeting certain company-wide performance goals, including sales,
operating profit margin, and cash flow targets. We estimate the fair value of RSU awards using the market price of our common stock on the date of the grant. The fair value of these awards is amortized on a straight-line basis over the vesting
period.

A summary of our RSU awards activity during the nine months ended September 30, 2010 is provided below:

Number of Shares

Weighted-AverageGrant Date
Fair Value(per share)

Nonvested at January 1, 2010

713,449

$

12.79

Granted

716,507

$

16.68

Vested

(473,110

)

$

11.01

Forfeited

(45,943

)

$

12.49

Nonvested at September 30, 2010

910,903

$

14.96

The total fair value of RSU awards vested during the nine months ended September 30, 2010 and
2009 was $6.8 million and $4.3 million, respectively.

The following table presents the income statement classification of all stock-based compensation
expense for the three months and nine months ended September 30, 2010 and 2009 (in thousands):

Three Months
EndedSeptember 30

Nine Months
EndedSeptember 30

2010

2009

2010

2009

Cost of services

$

329

$

185

$

711

$

522

Sales and marketing

1,991

1,047

4,352

3,767

Research and development

2,336

1,473

5,346

4,073

General and administrative

1,700

1,330

5,117

3,004

Total stock-based compensation

6,356

4,035

15,526

11,366

Tax benefit associated with stock-based compensation expense (1)

2,460

1,614

6,009

4,546

Reduction of net income

$

3,896

$

2,421

$

9,517

$

6,820

(1)

The recognized tax benefit related to share-based compensation expense is estimated to be 38.7% and 40.0% for the three months ended September 30, 2010 and 2009,
respectively, and 38.7% and 40.0% for the nine months ended September 30, 2010 and 2009, respectively. This approximates the blended Federal and State statutory tax rate after the benefit for state taxes.

As of September 30, 2010, total unrecognized stock-based compensation cost related to unvested stock option awards was $41.6
million, which is expected to be recognized over a weighted-average period of 3.5 years and total unrecognized stock-based compensation cost related to unvested RSU awards was $11.6 million, which is expected to be recognized over a weighted-average
period of 1.8 years.

NOTE 14  DERIVATIVE INSTRUMENTS

Foreign Exchange Risk Management Policy

Our Foreign Exchange Risk Management Policy identifies target exposures such as balance sheet, cash flow and income statement risks, program objectives, approved financial instruments and counterparties,
accounting and tax treatment, as well as oversight, reporting and controls. The functional currency of all our subsidiaries is the U.S. Dollar. Our exposure to foreign exchange risk originates both from the operating results of our foreign
operations denominated in currencies other than the U.S. Dollar, as well as our net balances of monetary assets and liabilities within our foreign subsidiaries. These exposures have the potential to produce either gains or losses depending on
the directional movement of the foreign currencies versus the U.S. Dollar and our operational profile in foreign subsidiaries. Certain balance sheet items are re-measured each period and the changes in value are recorded within other income
(expense), net.

We utilize a balance sheet hedging program with the stated objective of reducing volatility within other
income (expense), net. Under this program, we use derivatives in the form of forward foreign currency contracts to hedge certain balance sheet exposures. We do not designate these contracts as hedging instruments and therefore do not qualify
for hedge accounting. Accordingly, these outstanding non-designated derivatives are recognized on the condensed consolidated balance sheet at fair value and the changes in fair value from these contracts are recorded in other income (expense), net,
in the condensed consolidated income statement. These derivative contracts typically have a one month term.

We have a cash
flow hedging program primarily focused on reducing volatility in our forecasted research and development cash expenses and license revenues; some of which are denominated in non-U.S. Dollar currencies. Under this program, we use derivatives in
the form of forward foreign currency contracts and foreign currency option contracts to hedge certain forecasted transactions. These derivatives are designated as hedging instruments, with durations ranging from less than one month to twelve months,
and therefore qualify for hedge accounting. Accordingly, these outstanding designated derivatives are recognized on the condensed consolidated balance sheet at fair value. Changes in value that are highly effective are recognized in Accumulated
other comprehensive income (AOCI) on the condensed consolidated balance sheets, until the hedged item is recognized in the income statement. Any ineffective portion of a derivatives change in fair value is recorded in other income
(expense), net, in the condensed consolidated income statement. There was no material ineffectiveness in our cash flow hedging program for the nine months ended September 30, 2010.

During the second quarter of 2010, we entered into approximately $18.3 million in
forward foreign currency hedges for our anticipated acquisition of Völcker. This derivative was settled in the third quarter of 2010 as a result of our acquisition of Völcker in July 2010 (refer to Note 3  Acquisitions for further
details). We do not designate these types of contracts as hedging instruments. Accordingly, these outstanding non-designated derivatives are recognized on the condensed consolidated balance sheet at fair value and the changes in fair value from
these contracts are recorded in other income (expense), net, in the condensed consolidated income statement.

We had the
following notional amounts for our foreign currency contracts included in our condensed consolidated balance sheets (in U.S. Dollars in thousands):

We perform fair value measurements in accordance with FASBs guidance on Fair Value Measurements and
Disclosures. This standard defines fair value, provides guidance for measuring fair value and requires certain disclosures. This standard does not require any new fair value measurements, but rather applies under other accounting pronouncements
that require or permit fair value measurements. The standard discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to
replace the service capacity of an asset or replacement cost). The statement establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief
description of those three levels:



Level 1: Observable inputs such as quoted prices (unadjusted) in active markets that are accessible at the measurement date for identical, unrestricted
assets or liabilities.

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for
similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.



Level 3: Unobservable inputs that reflect the reporting entitys own assumptions when there is little or no market data.

We measure our financial assets and liabilities at fair value on a recurring basis using the following
valuation techniques:

(b) Income Approach  uses valuation techniques to convert future estimated cash flows to
a single present amount based on current market expectations about those future amounts, using present value techniques.

The
following table represents our fair value hierarchy and the valuation techniques used for financial assets and financial liabilities measured at fair value on a recurring basis (in thousands):

September 30, 2010

Total

Level 1

Level 2

Level 3

ValuationTechniques

Assets:

Money market funds

$

166,045

$

166,045

$



$



(a

)

U.S. treasury securities

37,537

37,537





(a

)

U.S. agency securities

39,946

39,946





(a

)

Corporate notes/bonds

59,289

59,289





(a

)

Certificates of deposit

6,183

6,183





(a

)

Commercial paper

45,055

45,055





(a

)

Derivative assets (1)

596



596



(a

)

Total

$

354,651

$

354,055

$

596

$



Liabilities:

Derivative liabilities (1)

4,495



4,495



(a

)

Contingent consideration (2)

6,015





6,015

(b

)

Total

$

10,510

$



$

4,495

$

6,015

December 31, 2009

Total

Level 1

Level 2

Level 3

ValuationTechniques

Assets:

Money market funds

$

178,303

$

178,303

$



$



(a

)

U.S. treasury securities

55,371

55,371





(a

)

U.S. agency securities

1,495

1,495





(a

)

Certificates of deposit

8,598

8,598





(a

)

Commercial paper

29,991

29,991





(a

)

ARS

44,229





44,229

(b

)

Put Options

3,330





3,330

(b

)

Derivative assets (1)

1,120



1,120



(a

)

Total

$

322,437

$

273,758

$

1,120

$

47,559

Level 3 as % of total

14.7

%

Liability:

Contingent consideration (2)

$

4,000

$



$



$

4,000

(b

)

(1)

See Note 14  Derivative Instruments for details.

(2)

$4.0 million relates to our acquisition of PacketTrap in 2009 and $2.0 million relates to our acquisition of Völcker in the third quarter of 2010. Refer to Note 3
 Acquisitions for further details on earn-out contingency relating to Völcker.

We held certain
assets that are required to be measured at fair value on a recurring basis. These assets included cash equivalents and investments. At December 31, 2009, included in our investments was $44.2 million par value (with a fair value of $47.6 million) in
ARS. We exercised our Put Options on July 1, 2010 under the Agreements with the investment firm that sold us our ARS and the investment firm transferred our remaining ARS of $4.5 million par value out of our account and replaced with cash,
fulfilling their obligation under the Agreements and reducing our auction rate securities to zero.

The following table
presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2010 and 2009 (in thousands):

Nine Months EndedSeptember
30

2010

2009

Total, beginning of the period

$

47,559

$

49,283

Realized gains on ARS included within other income (expense), net

3,322

5,778

Realized losses on put options included within other income (expense), net

(3,330

)

(5,298

)

Sale of ARS (par value)

(47,551

)

(850

)

Total, end of the period

$



$

48,913

Other Financial Assets and Liabilities

The carrying amounts of our other financial assets and liabilities including accounts receivable, accounts payable and accrued liabilities
approximate their respective fair values because of the relatively short period of time between their origination and their expected realization.

The book value and fair value of our current and long-term portion of loans payable as of September 30, 2010 are as follows (in thousands):

Book Value

Fair Value (1)

Current portion of loans payable

$

553

$

553

Long-term portion of loans payable

32,876

32,876

$

33,429

$

33,429

(1)

Estimated fair value of long-term debt is based on quoted prices for similar liabilities for which significant inputs are observable.

NOTE 16  CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject us to credit risk include accounts receivable. We believe that credit risks related to our accounts receivable are moderated by the diversity of our
products, customers and geographic sales areas. We monitor extensions of credit and have not experienced significant credit losses in the past. We maintain an allowance both for bad debts and for sales returns and cancellations and such losses and
returns have historically been within managements expectations. The Companys significant customers consist primarily of resellers. We have one reseller customer that accounted for 10.9% of our total revenues for the nine months
ended September 30, 2010. This customer also accounted for 16.8 % of our accounts receivable as of September 30, 2010.

Patent Litigation. On August 27, 2010, we filed a complaint in the United States District
Court for the District of Utah against Centrify Corporation and Likewise Software alleging that Centrifys DirectControl software and Likewises Enterprise software infringe Quests United States Patent No. 7,617,501 (the
501 Patent). Our complaint seeks money damages, costs, attorneys fees, and the entry of permanent injunctions against each defendant. A trial in the 501 Patent litigation has not yet been set.

On August 30, 2010, Centrify filed a complaint in the United States District Court for the Northern District of Utah against Quest
alleging that our Authentication Services software infringes Centrifys United States Patent No. 7,591,005 (the 005 Patent). Centrifys complaint seeks an unspecified amount of money damages, costs,
attorneys fees, and a permanent injunction. On October 21, 2010, we filed a motion to dismiss Centrifys complaint for failure to state a claim on which relief may be granted. The court has yet to rule on our motion to
dismiss, and a trial in the 005 Patent litigation has not been set. We believe the claims asserted against Quest by Centrify are without merit and we intend to defend vigorously against Centrifys infringement claims.

On August 31, 2010, we filed a petition with the United States Patent and Trademark Office alleging that Centrifys 005
Patent is invalid and requesting the Patent Office to commence an inter partes reexamination of the patentability of Centrifys 005 Patent. On September 30, 2010, Centrify filed a petition with the United States Patent
and Trademark Office alleging that our 501 Patent is invalid and requesting the United States Patent and Trademark Office to commence an inter partes reexamination of the patentability of our 501 Patent. We expect that the
Patent Office likely will issue a decision indicating whether it will reexamine Centrifys 005 Patent in early December 2010. The Patent Office likely will decide whether to reexamine our 501 Patent in early January
2011. If one or both petitions for reexamination are granted, patent examiners will be assigned to re-evaluate the patentability of one or both of the 501 and 005 patents. We believe that our 501 patent is valid and
enforceable and intend to vigorously defend the patentability of the 501 patent in the event that Centrifys petition for reexamination is granted.

General. The Company and its subsidiaries are involved in other legal proceedings, claims and litigation arising in the ordinary course of business. The foregoing discussion includes material
developments that occurred during the three months ended September 30, 2010 or thereafter in our material legal proceedings.

In the normal course of our business, we enter into certain types of agreements that require us to indemnify or guarantee the obligations of other parties. These commitments include (i) intellectual
property indemnities to licensees of our software products, (ii) indemnities to certain lessors under office space leases for certain claims arising from our use or occupancy of the related premises, or for the obligations of our subsidiaries
under leasing arrangements, (iii) indemnities to customers, vendors and service providers for claims based on negligence or willful misconduct of our employees and agents, (iv) indemnities to our directors and officers to the maximum
extent permitted under applicable law, and (v) letters of credit and similar obligations as a form of credit support for our international subsidiaries and certain resellers. The terms and duration of these commitments varies and, in some
cases, may be indefinite, and certain of these commitments do not limit the maximum amount of future payments we could become obligated to make there under; accordingly, our actual aggregate maximum exposure related to these types of commitments
cannot be reasonably estimated. Historically, we have not been obligated to make significant payments for obligations of this nature, and no liabilities have been recorded for these obligations in our financial statements included in this report.

22

Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations (MD&A) should be read in conjunction with
the condensed consolidated financial statements and notes to those statements included elsewhere in this Report. Certain statements in this Report, including statements regarding our business strategies, operations, financial condition and prospects
are forward-looking statements. Use of the words believe, expect, anticipate, will, contemplate, would, project, plan, may,
could, intend, likely, might, estimate, continue and similar expressions that contemplate future events may identify forward-looking statements.

Numerous important factors, risks and uncertainties affect our operations and could cause actual results to differ materially from those
expressed or implied by these or any other forward-looking statements made by us or on our behalf. Readers are urged to carefully review and consider the various disclosures made in this Report, including those described under Part I, Item 1A,
Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009, and in other filings with the SEC that attempt to advise interested parties of certain risks and factors that may affect our business, which are available on
the SECs website at www.sec.gov. Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect managements opinions only as of the date thereof. We do not
assume any obligation to revise or update forward-looking statements. Finally, our historic results should not be viewed as indicative of future performance.

Quest Software, Inc., together with our subsidiaries ScriptLogic and Vizioncore, delivers innovative products that help IT organizations get enhanced performance from their computing environment. Our
product areas are Application Management, Database Management, Windows Management and Virtualization Management. The focus of our products is based upon generating higher levels of performance, manageability and productivity throughout our
customers IT infrastructure with products and services that enable them to manage the investments they have made within their IT environment.

Quarterly Update

As discussed in more detail throughout our MD&A, for
the three months ended September 30, 2010 compared to the three months ended September 30, 2009, we delivered the following financial performance:



Total revenues increased by $22.2 million, or 13.0%, to $193.0 million while license revenues grew 19.7% to $80.6 million.



Total expenses decreased by $12.4 million, or 7.2%, to $160.4 million.



Income from operations increased to $32.6 million from a loss from operations of $2.0 million.



Diluted earnings per share increased by $0.28, or 933.3%, to $0.31.

23

Our third quarter 2010
total revenues increased by 13.0% compared to the same period in 2009, as our Americas sales region, which includes United States, Canada and Latin America was led by our U.S. Federal Government group and showed continuous improvement. Our EMEA
sales region, which includes Europe, the Middle East and Africa, as well as our Asia Pacific (APAC) sales region showed comparable revenues from the third quarter of 2009, although within our EMEA results, revenues in the U.K. continue
to be sluggish. Our Americas sales region contributed 69.1% of total revenues and the rest of the world contributed 30.9% of total revenues in the quarter as compared to 66.2% and 33.8% in the comparable quarter last year.

Our license revenues grew 19.7 % compared to the same period in 2009. The growth this quarter was achieved through balanced
contributions from our established products such as Toad, Active Directory and Exchange management products, as well as from newer products such as our Server and Desktop Virtualization, SharePoint and vFoglight management products. The increase in
our total revenues was primarily driven by increased sales of our Windows Management products, particularly our Exchange, Migration & Identity Management solutions, and related professional services. We expect continued strength in our Windows
Management products due to our customers migration to Microsoft Exchange Server 2010 and the growth within the Identity and Access Management (IDAM) market. In addition, we acquired Völcker in July 2010 and Surgient in August
2010 (refer to Note 3  Acquisitions of our Notes to Condensed Consolidated Financial Statements for further details). These acquisitions contributed to approximately 11.2% of our overall increase in total revenues compared to the same period
in 2009. Our acquisition of Völcker gives us access to a larger aspect of the Identity Access Management market and the continued expansion of our Identity Management solution capabilities whereas with Surgient, we added private cloud
management capabilities to our virtualization product portfolio. Revenues from our Virtualization Management products increased significantly compared to the same period in 2009. We expect this trend to continue as companies continue to embrace
virtual computing.We believe we are well positioned to capitalize on this major growth trend as we offer flexible solutions for managing virtualized IT infrastructure.

Total revenues were negatively impacted by the strong U.S. Dollar relative to certain non-U.S. Dollar currencies, including the Euro and British Pound. Since certain of our international sales
are denominated in these non-U.S. Dollar currencies, the impact from foreign currency resulted in lower US dollar equivalent sales of approximately $1.5 million.

Total expenses decreased compared to the same period in 2009. Total expenses in the third quarter of 2009 included a litigation loss provision of $29.4 million in connection with our settlement of the
shareholder class action relating to our completed stock option investigation. Excluding this amount, our total expenses increased compared to the third quarter of 2009. Our expenses primarily consist of personnel costs, which include compensation,
benefits and payroll related taxes and are primarily a function of our worldwide headcount. Our average full-time employee headcount for the third quarter of 2010 decreased to 3,388 compared to 3,408 for the third quarter of 2009. Our average
full-time employee headcount in locations outside of the United States was 1,560 for the third quarter of 2010, a decrease of 49 compared to 1,609 for the third quarter of 2009. Our third quarter 2010 total expenses were impacted by the strong
U.S. Dollar relative to the Euro and British Pound and this resulted in lower U.S. Dollar equivalent expenses. Since certain of our international expenses are denominated in non-U.S. Dollar currencies, our total expenses in the third
quarter of 2010 decreased by $1.4 million compared to the same period in 2009 as a result of the impact of foreign currency exchange rates when comparing 2010 rates to 2009. Net increase in total expenses, excluding the litigation loss provision in
the third quarter of 2009, was primarily due to the increase in sales and marketing expenses, $4.7 million of which was due to higher sales commissions as a result of higher revenues compared to the third quarter of 2009. Also, our acquisitions of
Völcker and Surgient contributed to approximately $4.2 million of the net increase in total expenses relating to their operating costs.

Foreign Currency

While we are a U.S. Dollar functional company on a
world-wide basis, we transact business and operate using multiple foreign currencies. As such, the value of our revenues, expenses, certain account balances and cash flows are exposed to fluctuations in foreign currencies against the value of the
U.S. Dollar. For example, when the U.S. Dollar strengthens against several non-U.S. Dollar currencies, our foreign revenues and thus our total revenues can be negatively impacted. Similarly, a stronger U.S. Dollar translates into
lower expenses in those entities where we have operations and our personnel and occupancy expenses are denominated in non-U.S. Dollars. Thus our total expenses would be lower. Conversely, a weaker U.S. Dollar would have the opposite effect on
total revenues and expenses all other things being equal. In certain geographic regions and within specific currencies, there are partial offsets between revenues and expenses or balance sheet positions that may reduce this exposure. In other
instances, we can manage our operations to reduce foreign currency exposure or utilize forward foreign currency contracts to manage this exposure.

24

Results of Operations

The following are percentage of total revenues:

Three Months EndedSeptember 30

Nine Months EndedSeptember 30

2010

2009

2010

2009

Revenues:

Licenses

41.7

%

39.4

%

40.5

%

38.2

%

Services

58.3

60.6

59.5

61.8

Total revenues

100.0

100.0

100.0

100.0

Cost of revenues:

Licenses

1.3

1.3

1.1

1.1

Services

8.8

8.5

8.6

8.6

Amortization of purchased technology

2.1

2.9

2.3

3.0

Total cost of revenues

12.2

12.7

12.0

12.7

Gross profit

87.8

87.3

88.0

87.3

Operating expenses:

Sales and marketing

38.4

37.9

39.0

39.3

Research and development

19.7

20.3

20.0

21.6

General and administrative

11.2

11.1

11.1

11.0

Litigation loss provision



17.2



5.9

Amortization of other purchased intangible assets

1.6

1.9

1.7

2.0

Total operating expenses

70.9

88.4

71.8

79.8

Income (loss) from operations

16.9

(1.1

)

16.2

7.5

Other income (expense), net

0.9

1.6

(1.0

)

0.7

Income before income tax provision (benefit)

17.8

0.5

15.2

8.2

Income tax provision (benefit)

3.0

(1.3

)

4.0

1.6

Net income

14.8

%

1.8

%

11.2

%

6.6

%

Comparison of Three Months Ended September 30, 2010 and 2009

Revenues

Total revenues and year-over-year changes are as follows (in thousands, except for percentages):

Three Months
EndedSeptember 30

Increase (Decrease)

2010

2009

Dollars

Percentage

Revenues:

Licenses

Americas

$

57,623

$

44,009

$

13,614

30.9

%

Rest of World

22,959

23,314

(355

)

(1.5

)%

Total license revenues

80,582

67,323

13,259

19.7

%

Services

Americas

75,678

69,049

6,629

9.6

%

Rest of World

36,782

34,477

2,305

6.7

%

Total service revenues

112,460

103,526

8,934

8.6

%

Total revenues

$

193,042

$

170,849

$

22,193

13.0

%

25

Our revenues for the
third quarter of 2010 is comprised of 41.7% of license revenues and 58.3% of service revenues compared to 39.4% of license revenues and 60.6% of service revenues in the third quarter of 2009.

License Revenues  The increase in license revenues was due primarily to increased sales of our Windows Management products.
Our Windows products, led by migration, continued to perform well due to customers adoption of Exchange 2010. Also, our Identity and Access Management products, a key growth area in our Windows Management business, continued to expand and gain
market share with the Quest One Identity Solution. Our 2010 license revenues were negatively impacted by $1.2 million from foreign currency.

Service Revenues  Service revenues are derived from post-contract technical support services (maintenance) and consulting and training services. The largest component of our
services revenues is maintenance revenue. Maintenance revenues are generated from support and maintenance services relating to current year sales of new software products and from the renewal of existing maintenance agreements for software
licenses sold in prior periods. The main driver of our growth in services revenues was maintenance renewals on our Windows Management products. Our acquisitions of Völcker and Surgient contributed to approximately $2.2 million of the overall
increase. Our professional services revenues contribution remained consistent with revenues from consulting and training services contributing 10.4% and 9.3% of total service revenues in the three months ended September 30, 2010 and 2009,
respectively.

Maintenance revenues continue to contribute a larger percentage of our total revenues primarily because of
maintenance contracts associated with our growing installed base of customers and because maintenance contract growth exceeds that of license contracts from time to time. As our maintenance customer base grows, maintenance renewals have a larger
influence on the maintenance revenue growth rate and the amount of new software license revenues has a diminishing effect. Therefore, the growth rate of total revenues does not necessarily correlate directly to the growth rate of new software
license revenues in a given period. The primary determinant of changes in our maintenance revenue profile is the extent to which our customers renew their annual maintenance agreements, taking into account the number of products and licenses for
which each customer renews, and the timing of the renewals by each such customer. If our maintenance renewals were to decline materially, our maintenance revenues, total revenues and cash flows would likely decline materially as well.

Cost of Revenues

Total cost of revenues and year-over-year changes are as follows (in thousands, except for percentages):

Three Months
EndedSeptember 30

Increase (Decrease)

2010

2009

Dollars

Percentage

Cost of Revenues:

Licenses

$

2,465

$

2,197

$

268

12.2

%

Services

16,907

14,607

2,300

15.7

%

Amortization of purchased technology

4,105

4,983

(878

)

(17.6

)%

Total cost of revenues

$

23,477

$

21,787

$

1,690

7.8

%

Cost of Licenses  Cost of licenses primarily consists of third-party software
royalties, product packaging, delivery, and personnel costs. Cost of licenses as a percentage of license revenues was 3.1% and 3.3% for the three months ended September 30, 2010 and 2009, respectively. Cost of licenses was comparable to the
same period in 2009.

Cost of Services  Cost of services primarily consists of personnel, outside consultants,
facilities and systems costs used in providing maintenance, consulting and training services. Cost of services does not include development costs related to bug fixes and upgrades which are classified in research and development and which are not
separately determinable. Cost of services as a percentage of service revenues was 15.0% and 14.1% in the three months ended September 30, 2010 and 2009, respectively. The increase in costs of services was primarily due to an increase of $1.4
million in personnel related costs compared to the same period in 2009.

26

Amortization of
Purchased Technology  Amortization of purchased technology includes amortization of the fair value of purchased technology associated with acquisitions. The decrease is due to past acquisition-related purchased technology being fully
amortized prior to July 1, 2010 coupled with fewer acquisitions completed during the past 18 months compared to the same period in 2009.

Operating Expenses

Year-over-year changes in the principal
components of our operating expenses are as follows (in thousands, except for percentages):

Three Months
EndedSeptember 30

Increase (Decrease)

2010

2009

Dollars

Percentage

Operating Expenses:

Sales and marketing

$

74,107

$

64,704

$

9,403

14.5

%

Research and development

38,124

34,721

3,403

9.8

%

General and administrative

21,585

18,971

2,614

13.8

%

Litigation loss provision



29,400

(29,400

)

(100

)%

Amortization of other purchased intangible assets

3,186

3,258

(72

)

(2.2

)%

Total operating expenses

$

137,002

$

151,054

$

(14,052

)

(9.3

)%

Sales and Marketing  Sales and marketing expenses consist primarily of compensation
and benefit costs for sales and marketing personnel, sales commissions, and costs of trade shows, travel and entertainment and various discretionary marketing programs. Sales and marketing expenses as a percentage of total revenues was 38.4% and
37.9% for the three months ended September 30, 2010 and 2009, respectively. The increase in sales and marketing expense during the three months ended September 30, 2010 over the comparable period in 2009 was due primarily to an increase of
$7.8 million in personnel related costs (partly due to performance salary increase program effective July 1, 2010), of which $4.7 million relates to higher commissions expense due to higher revenues compared to the third quarter of 2009. Also,
general expenses increased by $1.4 million related to advertising and associated expenses driven by events of VM World and Oracle Open World. Our average full-time sales and marketing employee headcount for the third quarter of 2010 was 1,374
compared to 1,436 in the third quarter of 2009. The positive impact from foreign currency was approximately $1.3 million.

Research and Development  Research and development expenses consist primarily of compensation and benefit costs for software
developers who develop new products, fix bugs and design upgrades to existing products and at times provide engineering support for maintenance services, software product managers, quality assurance and technical documentation personnel, and
payments made to outside software development consultants in connection with our ongoing efforts to enhance our core technologies and develop additional products. Research and development expenses as a percentage of total revenues was 19.7% and
20.3% for the three months ended September 30, 2010 and 2009, respectively. Research and development expense in the third quarter of 2010 increased over the same period in 2009 mainly because of the increase in personnel related costs by $3.1
million due to performance salary increase program effective July 1, 2010. Our average full-time research and development employee headcount for the third quarter of 2010 was 1,172 compared to1,183 in the third quarter of 2009.

General and Administrative  General and administrative expenses consist primarily of compensation and benefit costs for our
executive, finance, legal, human resources, administrative and information services personnel, and professional fees for audit, tax and legal services. General and administrative expenses as a percentage of total revenues were 11.2%, which is
comparable to 11.1% in the third quarter of 2009. The increase in general and administrative expense during the three months ended September 30, 2010 over the comparable period in 2009 was due mainly to an increase of $2.3 million in general
expenses (primarily professional and legal fees).

Litigation loss provision  Litigation loss provision of $29.4
million was recorded in the third quarter of 2009 in connection with our settlement of the shareholder class action relating to our completed stock option investigation.

27

Amortization of
Other Purchased Intangible Assets  Amortization of other purchased intangible assets includes the amortization of customer lists, trademarks and trade names, non-compete agreements and maintenance contracts associated with acquisitions.
The decrease is due to past acquisition-related other purchased intangible assets being fully amortized prior to July 1, 2010 coupled with fewer acquisitions completed during the past 18 months compared with the same period in 2009.

Other Income, Net

Other income, net consists of the following (in thousands):

Three Months
EndedSeptember 30

Increase (Decrease)

2010

2009

Dollars

Percentage

Interest income

$

682

$

325

$

357

109.8

%

Interest expense

(1,116

)

(962

)

(154

)

16.0

%

Foreign currency gains, net

5,379

3,360

2,019

60.1

%

Foreign currency contracts (losses) gains, net

(3,308

)

4

(3,312

)

(82,800

)%

Other income (expense), net

106

(24

)

130

(541.7

)%

Total other income, net

$

1,743

$

2,703

$

(960

)

(35.5

)%

Other income, net includes gains and losses from foreign exchange fluctuations, interest expense
on our borrowings and gains or losses on other financial assets as well as a variety of other non-operating expenses. Our foreign currency gains or losses are predominantly attributable to translation gains or losses relative to the U.S. Dollar
on the re-measurement of net monetary assets, including accounts receivable and cash, which were primarily denominated in the Euro, and to a lesser extent, the British Pound and Canadian Dollar. Our foreign currency gains increased by $2.0 million
compared to the third quarter of 2009. This was offset by a decrease in our foreign currency contracts gains from a gain of $4 thousand to a loss of $3.3 million compared to the same period in 2009. Our foreign currency contracts (losses) gains, net
relate to the changes in fair value of our foreign currency contracts not designated as hedging instruments. Interest expense was $1.1 million and $1.0 million in the three months ended September 30, 2010 and 2009, respectively.

Income Tax Provision

During the three months ended September 30, 2010, our income tax provision increased to $5.8 million from an income tax benefit of $2.2 million in the comparable period in 2009. The effective
income tax rate for the three months ended September 30, 2010 was approximately 16.9% compared to (314.8)% in the comparable period of 2009. The increase is primarily a result of the mix of pre-tax income between high and low tax jurisdictions
and settlement of the shareholder class action in the third quarter of 2009 related to the completed stock option investigation impacting the quarter ended September 30, 2010.

Comparison of Nine Months Ended September 30, 2010 and 2009

Revenues

Total revenues and year-over-year changes are as follows (in thousands, except for percentages):

Nine Months
EndedSeptember 30

Increase (Decrease)

2010

2009

Dollars

Percentage

Revenues:

Licenses

Americas

$

145,919

$

121,022

$

24,897

20.6

%

Rest of World

76,744

70,311

6,433

9.1

%

Total license revenues

222,663

191,333

31,330

16.4

%

Services

Americas

219,362

210,376

8,986

4.3

%

Rest of World

108,290

98,995

9,295

9.4

%

Total service revenues

327,652

309,371

18,281

5.9

%

Total revenues

$

550,315

$

500,704

$

49,611

9.9

%

28

Our revenues for the
nine months ended September 30, 2010 is comprised of 40.5% of license revenues and 59.5% of service revenues compared to 38.2% of license revenues and 61.8% of service revenues for the same period in 2009.

License Revenues  The increase in license revenues was due primarily to increased sales of our Windows Management and
Database Management products. Our 2010 license revenues were positively impacted by the weak U.S. Dollar relative to certain non-U.S. Dollar currencies in 2010, partially offset by an appreciating U.S. Dollar relative to the Euro and
British Pound in the third quarter of 2010. This resulted in higher U.S. Dollar equivalent revenues for several currencies. Since certain of our international sales are denominated in non-U.S. Dollar currencies, the impact from foreign
currency comprised approximately $3.1 million, or 9.8%, of the overall increase in license revenues.

Service Revenues
 The main driver of our growth in services revenues was maintenance renewals on our Windows Management products across all sales regions. Revenue from consulting and training services as a percentage of total service revenues was
approximately 9.7% and 8.8% of total service revenues in the nine months ended September 30, 2010 and 2009, respectively.

Cost of Revenues

Total cost of revenues and year-over-year changes are as follows (in thousands, except for percentages):

Nine Months
EndedSeptember 30

Increase (Decrease)

2010

2009

Dollars

Percentage

Cost of Revenues:

Licenses

$

6,178

$

5,740

$

438

7.6

%

Services

47,267

42,867

4,400

10.3

%

Amortization of purchased technology

12,564

14,924

(2,360

)

(15.8

)%

Total cost of revenues

$

66,009

$

63,531

$

2,478

3.9

%

Cost of Licenses  Cost of licenses as a percentage of license revenues was 2.8% and
3.0% for the nine months ended September 30, 2010 and 2009, respectively. Cost of licenses was comparable to the same period in 2009.

Cost of Services  Cost of services as a percentage of service revenues was 14.4% and 13.9% in the nine months ended September 30, 2010 and 2009, respectively. The impact from foreign
currency comprised approximately$0.9 million, or 20.8%, of the overall increase in cost of services. The increase in costs of services was primarily due to an increase of $2.6 million in personnel related costs compared to the same period in 2009.

Amortization of Purchased Technology  The decrease is due to past acquisition-related purchased technology being
fully amortized prior to January 1, 2010 coupled with fewer acquisitions completed during the past 18 months compared to the same period in 2009.

29

Operating
Expenses

Year-over-year changes in the principal components of our operating expenses are as follows (in thousands,
except for percentages):

Nine Months
EndedSeptember 30

Increase (Decrease)

2010

2009

Dollars

Percentage

Operating Expenses:

Sales and marketing

$

214,529

$

196,732

$

17,797

9.0

%

Research and development

110,140

107,928

2,212

2.0

%

General and administrative

60,758

55,170

5,588

10.1

%

Litigation loss provision



29,400

(29,400

)

(100.0

)%

Amortization of other purchased intangible assets

9,512

9,925

(413

)

(4.2

)%

Total operating expenses

$

394,939

$

399,155

$

(4,216

)

(1.1

)%

Sales and Marketing  Sales and marketing expenses as a percentage of total revenues
for the nine months ended September 30, 2010 was 39.0%, which is comparable to 39.3% for the same period in 2009. The increase in sales and marketing expense during the nine months ended September 30, 2010 over the comparable period in
2009 was due primarily to an increase in personnel related costs of $14.0 million (partly due to performance salary increase program effective July 1, 2010), $9.2 million of which relates to higher commissions expense due to higher revenues
compared to the nine months ended September 30, 2009. Our average full time sales and marketing employee headcount for the nine months ended September 30, 2010 decreased by 88 employees. Also, travel-related expenses and general expenses
increased by a total of $3.8 million compared to the same period in 2009, primarily due to the events of VM World and Oracle Open World. The impact from foreign currency comprised approximately 15.6%, or $2.8 million of the overall increase in sales
and marketing expenses.

Research and Development  Research and development expenses as a percentage of total
revenues was 20.0% and 21.6% for the nine months ended September 30, 2010 and 2009, respectively. Research and development expenses increased mainly due to the impact of the weak U.S. Dollar, offset by an appreciating U.S. Dollar
relative to the Euro and British Pound, as a significant portion of our developers are located outside of the U.S. Foreign currency had a negative impact of $3.4 million on research and development expenses for the nine months ended
September 30, 2010.

General and Administrative  General and administrative expenses as a percentage of
total revenues was 11.1% and 11.0% for the nine months ended September 30, 2010 and 2009, respectively. The increase in general and administrative expense during the nine months ended September 30, 2010 over the comparable period in 2009
was due mainly to an increase in general expenses (primarily professional and legal fees) of $3.1 million.

Litigation loss
provision  Litigation loss provision of $29.4 million was recorded in the third quarter of 2009 in connection with our settlement of the shareholder class action relating to our completed stock option investigation.

Amortization of Other Purchased Intangible Assets  The decrease is due to past acquisition-related other purchased
intangible assets being fully amortized prior to January 1, 2010 coupled with fewer acquisitions completed during the past 18 months compared with the same period in 2009.

Other (Expense) Income, Net

Other (expense) income, net consists of the following (in thousands):

Nine Months
EndedSeptember 30

Increase (Decrease)

2010

2009

Dollars

Percentage

Interest income

$

1,526

$

1,519

$

7

0.5

%

Interest expense

(3,355

)

(1,687

)

(1,668

)

98.9

%

Foreign currency (losses) gains, net

(3,474

)

4,347

(7,821

)

(179.9

)%

Foreign currency contracts losses, net

(803

)

(1,405

)

602

(42.8

)%

Other income, net

400

563

(163

)

(29.0

)%

Total other (expense) income, net

$

(5,706

)

$

3,337

$

(9,043

)

(271.0

)%

30

The largest impact to
other (expense) income, net this period was attributed to a foreign currency loss of $3.5 million compared to a gain of $4.3 million in the comparable period of 2009 due to the relative strength in the U.S. Dollar that negatively impacted our
net monetary asset positions. This was partially offset by a decrease in our foreign currency contract losses of $0.6 million. Interest expense was $3.4 million and $1.7 million in the nine months ended September 30, 2010 and 2009,
respectively. The increase in interest expense is due to debt agreements entered during the second half of 2009. See Note 8  Loans Payable of our Notes to Condensed Consolidated Financial Statements for additional information regarding our
debt agreements.

Income Tax Provision

During the nine months ended September 30, 2010, the provision for income taxes increased to $22.2 million from $8.0 million in the comparable period in 2009. The effective income tax rate for
the nine months ended September 30, 2010 was approximately 26.5% compared to 19.4% in the same period of 2009. The increase is primarily a result of the mix of pre-tax income between high and low tax jurisdictions and settlement of the
shareholder class action in 2009 related to our completed stock option investigation.

Liquidity and Capital Resources

Cash and cash equivalents and short-term and long-term investments were approximately $410.2 million and $385.5 million as of
September 30, 2010 and December 31, 2009, respectively.

At December 31, 2009, we had within short-term investments
$47.6 million par value (with a fair value of $44.2 million) of investment grade municipal notes with an auction reset feature (auction rate securities or ARS). These securities are collateralized by higher education funded
student loans which are supported by the federal government as part of the Federal Family Education Loan Program (FFELP). We exercised our Put Options on July 1, 2010 under the Agreements and we redeemed our remaining ARS of $4.5
million.

Summarized annual cash flow information is as follows (in thousands):

Nine Months
EndedSeptember 30

2010

2009

Cash provided by operating activities

$

122,611

$

115,833

Cash used in investing activities

(148,656

)

(20,387

)

Cash used in financing activities

(30,547

)

(7,406

)

Effect of exchange rate changes

918

(470

)

Net (decrease) increase in cash and cash equivalents

$

(55,674

)

$

87,570

Operating Activities

Cash provided by operating activities is primarily comprised of net income, adjusted for non-cash activities such as depreciation and amortization and compensation expense associated with share-based
payments. These non-cash adjustments represent charges reflected in net income and, therefore, to the extent that non-cash items increase or decrease our future operating results, there will be no corresponding impact on our cash flows. After
excluding the effects of these non-cash charges, the primary changes in cash flows relating to operating activities resulted from changes in operating assets and liabilities. The analyses of the changes in our operating assets and liabilities are as
follows:



Accounts receivable, net decreased by $13.4 million to $144.2 million at September 30, 2010 compared to December 31, 2009 resulting in a
decrease in operating assets and reflecting a cash inflow of $14.2 million for the nine months ended September 30, 2010. Days sales outstanding (DSO), improved to 69 days at September 30, 2010 compared to 75 days at
December 31, 2009. Our daily sales was $2.1 million for the quarter ended September 30, 2010 and December 31, 2009. Collection of accounts receivable and related DSO could fluctuate in future periods due to the timing and amount of
our revenues and their linearity and the effectiveness of our collection efforts.

31



Deferred revenue increased by $6.9 million at September 30, 2010 from $372.1 million at December 31, 2009, resulting in an increase in
operating liabilities and reflecting a cash inflow of $3.2 million for the nine months ended September 30, 2010. The increase in deferred revenue was due primarily to the increase in sales of our time-based software licenses and to the growth
of our post-contract services customer base.



Accrued compensation decreased by $0.3 million to $45.6 million at September 30, 2010 compared to December 31, 2009 resulting in a decrease
in operating liabilities and reflecting a cash outflow of $4.3 million for the nine months ended September 30, 2010.



Income taxes payable decreased by $5.1 million to $31.2 million at September 30, 2010 compared to December 31, 2009 resulting in a decrease
in operating liabilities and reflecting a cash outflow of $7.2 million for the nine months ended September 30, 2010. Net cash paid for income taxes for the nine months ended September 30, 2010 was $23.5 million.

Investing Activities

Cash flows from investing activities in the nine months ended September 30, 2010 included $11.3 million in capital expenditures, $2.2 million from purchases of software rights, $216.2 million from
purchases of investment securities, and $2.0 million notes receivable funded to one of our cost method investees that was converted to equity in the third quarter of 2010 (Refer to Note 7  Cost Method Investments of our Notes to Condensed
Consolidated Financial Statements for additional details). We received $139.3 million in proceeds from sale and maturities of our investment securities.

In addition, we acquired Völcker, a German company with a product called ActiveEntry in the Identity Access Management market, and Surgient, a Texas-based cloud management company for a total cash
consideration of $55.2 million for these acquisitions (refer to Note 3  Acquisitions of our Notes to Condensed Consolidated Financial Statements for additional details).

We expect that we will continue to purchase property and equipment needed in the normal course of our business. We plan to use excess cash generated from operations to invest in short and long-term
investments consistent with past investment practices. Also, we plan to use cash generated from operations and/or proceeds from our investment securities to fund other strategic investment and acquisition opportunities that we continue to evaluate.

Financing Activities

Cash used in financing activities in the nine months ended September 30, 2010 included $37.4 million paid for repurchases of our common stock and $32.5 million for repayment of loans outstanding. We
received net proceeds of $37.3 million from the issuance of our common stock due to exercises of stock options.

In August
2009, our Board of Directors authorized a stock repurchase of up to $100 million of our common stock. Refer to Note 12  Stockholders Equity for further information on our stock repurchases. During the three months ended
September 30, 2010, we have no share repurchases. A total of $51.5 million remains available pursuant to this stock repurchase authorization.

We were in compliance with all debt-related covenants at September 30, 2010. For additional information on our loans payable, please refer to Note 8  Loans Payable of our Notes to Condensed
Consolidated Financial Statements.

As we continue to evaluate potential acquisitions, potential future stock repurchases or
other general corporate expenditures which may be in excess of current cash available within certain operating entities, sourcing cash to fund these activities requires financial flexibility afforded by financing instruments. As such, we plan to
continue to evaluate potential debt financings when and if reasonable financing terms become available to us.

32

Based on our current
operating plan, we believe that our existing cash, cash equivalents, investment balances, cash flows from operations and available debt financing will be sufficient to finance our operational cash needs through at least the next 12 to 24 months. Our
ability to generate cash from operations is subject to substantial risks described under Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009. One of these risks is that our future business
does not stay at a level that is similar to, or better than, our recent past. In that event, we may be unable to generate or sustain positive cash flow from operating activities. We would then be required to use existing cash, cash equivalents,
investment balances and debt financing to support our working capital and other cash requirements. Also, acquisitions are an important part of our business model. As such, significant amounts of cash could and will likely be used in the future for
additional acquisitions or strategic investments. If additional funds are required to support our working capital requirements, acquisitions or other purposes, we may seek to raise funds through public or private equity or, as discussed above, debt
financing or from other sources. We can provide no assurance that additional financing will be available at all or, if available, that we would be able to obtain additional financing on terms favorable to us.

The preparation of financial statements in accordance with generally accepted accounting principles requires us to
make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses. On an on-going basis, we make and evaluate estimates and judgments, including those related to revenue recognition, asset valuations
(including accounts receivable, goodwill and intangible assets), share-based compensation, income taxes and functional currencies for purpose of consolidation. We base our estimates on historical experience and various other assumptions that are
believed to be reasonable under the circumstances. Our estimates form the basis for making judgments about amounts and timing of revenue and expenses, the carrying values of assets, and the recorded amounts of liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates and such estimates may change if the underlying conditions or assumptions change. We have discussed the development and selection of the critical accounting policies with
the Audit Committee of our Board of Directors, and the Audit Committee has reviewed our related disclosures. The critical accounting policies related to the estimates and judgments listed above are discussed further in our Annual Report on Form 10-K
for the year ended December 31, 2009 under Part II, Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations. There have been no material changes to our critical accounting policies or estimates
during the nine months ended September 30, 2010.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Foreign Exchange Risk

We are a U.S. Dollar functional company
and transact business in a number of different foreign countries around the world. In most instances, revenues are collected and operating expenses are paid in the local currency of the country in which we are transacting. Accordingly, we are
exposed to both transaction and translation risk relating to changes in foreign exchange rates.

Our exposure to foreign
exchange risk originates both from our foreign operations net profits and losses denominated in currencies other than the U.S. Dollar, as well as our net balances of monetary assets and liabilities in our foreign subsidiaries. These exposures
have the potential to produce either gains or losses depending on the directional movement of the foreign currencies versus the U.S. Dollar and our operational profile in foreign subsidiaries. Our cumulative currency gains or losses in any
given period may be lessened by the economic benefits of diversification and the correlative relationships of different currencies, but there can be no assurance that this pattern will continue to be true in future periods. During the three and nine
months ended September 30, 2010, foreign currency fluctuation had an impact of $(1.5) million and $3.3 million, respectively, on total revenues and an impact of $(1.4) million and $7.6 million, respectively, on total expenses when comparing
2010 rates to 2009. In addition, during the three months and nine months ended September 30, 2010, we had a $5.4 million and $(3.5) million, respectively, in foreign currency gains (losses) within other income (expense), net compared to a $3.4
million and $4.3 million foreign currency gains in the comparable periods in 2009.

33

The foreign currencies to which we currently have the most significant exposure are the
Euro, the Canadian Dollar, the British Pound, the Australian Dollar and the Russian Ruble. During 2009, we implemented a limited foreign exchange hedging program. We enter into hedges in the form of foreign currency contracts to reduce the range of
outcomes foreign currency rate changes can have on non-functional currency denominated forecasted transactions and balance sheet positions, which include certain monetary assets and liabilities denominated in foreign currencies. The foreign currency
contracts are carried at fair value and denominated in various currencies as listed in the tables below. The duration of contracts ranges from less than one month to twelve months. A description of our accounting for foreign currency contracts is
included in Note 14  Derivative Instruments of our Notes to Condensed Consolidated Financial Statements.

The magnitude
of success of our hedging activities depends upon the accuracy of our estimates of various balances and transactions denominated in non-functional currencies. To the extent our estimates are correct, gains and losses on our foreign currency
contracts will be offset by corresponding losses and gains on the underlying transactions. In order to monitor the financial impact of our foreign currency hedges, we subject our hedges to a stress test. This test is intended to quantify the impact
to our financial statements of an abnormal change in the foreign currency rates in which we do business. When subjected to a 10% and 20% adverse change, we estimated that the fair value of our contracts would decline by $8.3 million and $16.7
million, respectively.

We do not use foreign currency contracts for speculative or trading purposes. We enter into
foreign currency contracts with reputable financial institutional counterparties whose financial health we monitor. To date, we have not experienced nonperformance by any of these counterparties and anticipate performance by all counterparties.

The following table summarizes the notional amounts of our outstanding foreign currency contracts at September 30, 2010
and December 31, 2009. All contracts have maturities of nine months or less. ( in U.S. Dollars in thousands):

Currency

September 302010

December 312009

Australian Dollar

$

3,524

$

2,545

Canadian Dollar

5,442

11,554

Danish Krone

1,097

1,214

Euro

40,782

21,991

British Pound

19,996

9,965

Israeli Shekel

2,058

1,947

Brazil Real

3,521



Swedish Krona

296



Norwegian Krone

679



Russian Ruble

6,104

5,586

Total

$

83,499

$

54,802

Interest Rate Risk

Our exposure to market interest-rate risk relates primarily to our investment portfolio. We traditionally do not use derivative financial instruments to hedge the market risks of our investments. We place
our investments with high-quality issuers and money market funds and articulate allocation limits in our investment policy to any one issuer other than the United States government. Our investment portfolio as of September 30, 2010 consisted of
money market funds, U.S. Treasuries, US agency securities, commercial paper, certificates of deposit and corporate bonds. Investments purchased with an original maturity of three months or less is considered to be cash equivalents. We classify our
investments as available-for-sale securities. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of stockholders equity. Trading securities are carried at
fair value, with changes in fair value reported in earnings.

34

Information about our
investment portfolio is presented in the table below, which states the amortized book value and related weighted-average interest rates by year of maturity (in thousands):

AmortizedBook Value

WeightedAverage Rate

Investments maturing by September 30

2011(1)

$

259,004

0.3

%

2012

55,950

1.2

%

2013

38,663

1.4

%

2014





2015





Thereafter





Total portfolio

$

353,617

0.6

%

(1)

Includes $181.1 million in cash equivalents.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as
amended (the Exchange Act) is recorded, processed, summarized and reported within the specified time periods and accumulated and communicated to management, including our chief executive officer and chief financial officer, as
appropriate, to allow timely decisions regarding required disclosure.

Our management, with the participation of our chief
executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2010 as required by paragraph (b) of Rule 13a-15 or Rule 15d-15 of the Exchange Act. Based on that
evaluation, our chief executive officer and chief financial officer have concluded that, as of that date, our disclosure controls and procedures as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act were effective, at the reasonable
assurance level.

In October 2009, we began implementing an upgrade to our financial system. As part of the first stage of
this process, which we completed in August 2010, we implemented a full rollout of all financial system upgrade modules in the United States, Canada, Australia and certain parts of our EMEA region, which together comprise the largest part of our
business. The second and final stage of implementation of the upgrade to our financial system is the rollout of the remaining modules to the rest of our company, which is scheduled to be completed in the third quarter of 2011. Our upgraded financial
system is a significant component of our internal control over financial reporting. Management believes that it has taken the necessary steps to monitor and maintain appropriate internal controls during this implementation period and that our
internal controls have been enhanced by the new financial accounting system.

Changes in Internal Control Over Financial
Reporting

There have been no other changes in our internal control over financial reporting that occurred during the
quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

35

PART IIOTHER
INFORMATION

Item 1.

Legal Proceedings

The
information set forth under Note 17  Commitments and Contingencies of our Notes to Condensed Consolidated Financial Statements, included in Part I, Item 1, Financial Statements, of this Report, is incorporated herein by
reference. For an additional discussion of certain risks associated with legal proceedings, see the section entitled Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009.

Item 1A.

Risk Factors

You should
carefully consider the risks described in Part I, Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2009, as our business, financial condition and results of operations could be adversely affected by
any of the risks and uncertainties described therein. There have been no material changes in our risk factors from those disclosed in our 2009 Form 10-K.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

The table below summarizes
information about our purchases of equity securities registered pursuant to Section 12 of the Exchange Act during the quarterly period ended September 30, 2010.

In August 2009, the Board of Directors authorized a plan to repurchase up to $100 million of our common stock. Any stock repurchases may be made through open
market and privately negotiated transactions, at times and in such amounts as management deems appropriate, including pursuant to one or more Rule 10b5-1 trading plans. Rule 10b5-1 permits Quest to establish, while not in possession of material
nonpublic information, prearranged plans to buy stock at a specific price in the future, regardless of any subsequent possession of material nonpublic information. The timing and actual number of shares repurchased will depend on a variety of
factors including market conditions, corporate and regulatory requirements, and capital availability. The stock repurchase program does not have an expiration date and may be limited or terminated at any time without prior notice.

(2)

The price paid per share of common stock does not include the related transaction costs.

36

Item 6.

Exhibits

ExhibitNumber

Exhibit Title

3.1*

Certificate of Incorporation of Quest Software, Inc. (incorporated by reference to our Current Report on Form 8-K filed on April 30, 2009)

3.2*

Bylaws of Quest Software, Inc. (incorporated by reference to our Current Report on Form 8-K filed on April 30, 2009)

4.1*

Form of Registrants Specimen Common Stock Certificate (incorporated by reference to our Registration Statement on Form S-1 and all amendments thereto filed on June 11, 1999
(File No. 333-80543))

31.1

Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

31.2

Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended.

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